Belle Meade Title & Escrow

Belle Meade Title and Escrow: April 2011

Tuesday, April 12, 2011

Over the years I have received many questions about land trusts. Among the questions are: Are they effective for asset protection? Do they hide the owner’s identify? Can I assign the beneficial interest in the trust? Who should be my trustee? It eventually dawned on me that the questions seemed to show a need to enhance people’s understanding of land trusts. In this article, I am attempting to provide a brief description of what land trusts are and to weigh the pros and cons of the use of land trusts in Tennessee by real estate investors. I hope this information is of use to the readers.

I see two types of land trusts in Tennessee. The first type of land trust is not the subject of this article. This is the Conservation Land Trust which is used to preserve, in perpetuity, agricultural, forest, woodlands and historic properties and land in this state. The second type of land trust is modeled on what is often call an “Illinois” land trust. This type of trust originated in Chicago in the latter part of the 19th century. City officials who wanted to be involved in commercial real estate development desired to have some type of “blind” trust to hide their interest in real estate projects. The Illinois Supreme Court held that these trusts are valid if the trustee has at least has some minimal purposes. The use of land trust has spread to other states in recent years.

Illinois and at least five other states have enacted statutes that specifically identify and adopt this type of trust. Tennessee has not enacted such a statute. The Tennessee law on trust is more flexible than those of many states and although some people feel that land trusts are illegal or are not trusts, I see no authority for these positions. The IRS does consider land trusts as “sham” trusts for tax purposes in that it does not recognize the trust as an independent taxable entity from the beneficiary. However, I have found no legal prohibition of land trusts in Tennessee.

Tennessee has adopted the Tennessee Uniform Trust Code found at Tennessee Code Annotated 35-15-101 et. seq. This statute requires the Trustee to have duties to perform and that the same person is not the sole Trustee and the sole beneficiary. This is not a problem I have encountered in most land trusts. I have seen Land Trust Agreements normally define the role of the Trustee and give the Trustee some limited role. The requirements for creation of a trust are specified in T.C.A. 35-15-402. My review of the above statues leads me to believe that if the Trustee had no role whatsoever, the trust might not be considered to be a valid trust in Tennessee. Otherwise, most land trusts seem to meet the criteria to be considered as some form of trust in Tennessee.

The typical land trust includes a Grantor, a Trustee and one or more beneficiaries. The Grantor is often the property owner or the seller to the trust. The trustee is usually a separate person or entity familiar to the beneficiary. The beneficiary is the investor/owner. Title is held by the Trustee as a fiduciary for the Trust. The Trust is normally given a name of the street on which the property is located or may even contain the name of the Seller(s). It could also be named by almost whatever name the investor wants to use to suit his/her purposes. It usually does not contain the name of the beneficiary/investor. There can be multiple beneficiaries or the beneficiary can also be an LLC, corporation or other entity.

The land trust is beneficial to investors in that it hides the identity of the beneficiary who controls the Property and the trustee. The Trust Agreement is not recorded. The deed to the Trust names the trust but it does not mention the beneficiary. The deed usually shows the address of the trust as being a post office box or UPS store address or similar facility. It provides some protection from legal liability in that it is difficult to find the identity of the beneficiary. However, it is not foolproof. If a creditor “pierces” the trust through legal process and discovery, the identity of the beneficiary can be exposed and his or her assets can be attached unless the beneficiary is an LLC or other limited liability entity. Land Trusts usually permit for assignment of the beneficial interest which can change transfer and control of real estate without a recorded instrument. Another advantage of the land trust is that a separate trust can be set up for each property you own. This spreads out the risk among various trusts, which is a goal of many investors. Many investor use an LLC or corporation as the beneficiary to protect other personal assets.

A disadvantage of the land trust is that they are not understood by most lenders. Also, lenders generally want a copy of the trust agreement. If you give this to a lender, the structure of the trust is known to them and this may diminish the value of the trust and its ability to protect assets and the identity of the beneficiary. Another disadvantage is that unless the beneficiary is a limited liability entity, the beneficiary and his or her assets may be exposed to creditors who are able to learn the identity of the beneficiary. Finally, it is difficult to find a reliable trustee or even anyone that wants to serve and for this reason I often recommend forming a corporation to do nothing but to serve as trustee of your trust or trusts.

Land Trusts are another tool in the arsenal of the real estate investor. They are not for all investors. I have found that they work best when the investor owns the property outright or participates in a “subject to” transaction. They are also beneficial if you intend to hold the property for long periods of time. They are less useful if you intend to refinance on a frequent basis. Don’t utilize this form of ownership unless you fully study and comprehend the pros and cons of trust ownership. Seek independent tax, legal and insurance advice before using this form of ownership.